Merger Arbitrage Blog

Risky NXPI Trade

For those following or investing in NXP semiconductor for merger arbitrage, you would have been taken on a wild roller coaster ride this year. The stock was going up nicely before turmoil started early this year.

First, NXPI lost ground after a bid for Qualcomm came in from Broadcom, threatening the merger for NXPI as Broadcom was unwilling for Qualcomm to increase its offer for NXPI, effectively dooming the merger. Then NXPI suddenly rose to $125 after Qualcomm announced that they are increasing their merger offer price from $110 to $127.50 and this announcement marks the start of the end for Broadcom’s bid.

CFIUS came in later in March to kill off any chance of Broadcom acquiring Qualcomm, but NXPI’s share price did not benefit as increasing worries regarding MOFCOM approval, U.S and China trade spat, ZTE embargo (these sanctions will cause the collapse of ZTE as they will be unable to source vital electronic parts from U.S) and finally the suspension of MOFCOM regulatory process for the merger caused the share price to slide to the low $100s. A bad quarterly result for NXPI crashed the stock price further to low $90s by early May 2018. Qualcomm was also forced to refile for MOFCOM approval in the meantime.

Within a few weeks in Mid-May, President Trump indicated that he is willing to work with China to resolve ZTE’s issues, culminating in an agreement between U.S government with ZTE by imposing new penalties in order to open up the embargo. This caused the share price to once again spike up to low $120s as rumors came in that MOFCOM would approve the Qualcomm/NXPI merger in return for scrapping the sanctions on ZTE.

However, barely one week later, news came again that U.S senators are coming up with a bipartisan bill to add the sanctions back via a major defence bill. Then came an embarrassing blunder by South China Morning Post that declared MOFCOM had given the green light on the deal on 14th Jun 2018, reiterated by major news networks like Bloomberg and Reuters only for them to realize the next day that no official announcement was coming fore. And on the day, President Trump declared the final list of tariffs against China, escalating the trade conflict and investors dumped NXPI shares all day long on 15th June.

I know it’s a long winded story but that’s the current situation with the merger arbitrage trade with NXPI. I guess we can never say never until the cash hits the account as I was also guilty of celebrating too early on 14th June when the false news came out.

Nevertheless, I am still confident that the parties (U.S and China, ZTE and Qualcomm and NXPI) will come to an agreement ultimately because failing to do so simply makes all parties losers. China would not want ZTE to fail and we are talking about a major company bankruptcy where 80,000 people will be out of jobs and billions in value vaporized. On the other side, U.S chips suppliers will get a hit although not as critical as the Chinese company.

Actually I do not understand the leverage that China has on Qualcomm+NXPI. Without the merger, both companies can continue to do well but without ZTE, the big financial shock wave can cause many small suppliers in China to suffer badly. Obviously blocking the merger won’t affect U.S one bit, but China, on the other, would do well to approve the merger although a little bit of delay would also help China save face in the event U.S continues to implement the tariffs. China is now the only country in the world not to approve the merger and if China blocks the merger, it would reflect badly on China’s ambition and world standing to be petty and ambiguous regarding its business policies. Qualcomm’s CEO Steve Mollenkopf mentioned back in late April:

“I think it’d be a very unusual situation for the rest of the world to approve something and then China not do it, it’s a good situation for China to get this deal done, and you know I have confidence that that’ll happen…. Real discussions oftentimes lead to settlements and lead to a conclusion of hostilities, and I think that’s likely to be the case here. We don’t know when, but we’re prepared either way.”

Steve Mollenkopf later mentioned on news that “he was happy to see it” after Commerce Secretary Wilbur Ross announced a deal to end sanctions on China’s ZTE Corp on 7th June 2018.

In the meantime, President Trump has been steadfast in his support for ZTE’s survival even if his senators rebuked him by pushing for the maximum punishment on ZTE. On 19th Jun 2018, news reported President Trump will pressure GOP senators to soften the sanctions on ZTE to enable it to survive. With President Trump’s backing on saving the ZTE deal, there is a higher chance that a compromise may be achieved. House committee members and senate have to reconcile both versions of their bill and that is where the language for sanctioning ZTE maybe watered-down. This process may take weeks.

There are also concerns that China ties in the tariffs together with ZTE on Qualcomm+NXPI merger approval. However, if Trump is able to negotiate a settlement with senate members regarding ZTE sanctions which will still allow ZTE to continue to exist, then I think NXPI’s share price will spike.

I acknowledge that this trade is high risk and binary. I would buy more if the share price trends towards low $100s and below as further downside should be minimal and having tremendous upside if a deal happens. The trick would be to buy in slowly, conserving firepower in case the price really drops below $100. As for the chance of a merger approval by dropdead date in mid July from China without a U.S ZTE and Tariff deal, I believe the chances are only 30%. If U.S is somehow able to come to a deal regarding ZTE, then the chances will improve to 50% and if both tariffs and ZTE issues are resolved, then approval will be as good as 95%. In the event ZTE issues are solved, I would suggest not to wait for NXPI close and instead take profit if the price exceeds $120 as anything can happen with this merger after so many twists and turns.

Do note that above are my views and should not be used as an investment advise. Do invest wisely and with caution. Disclaimer: I am long NXPI. This is my largest position currently.

Updated: June 20, 2018 — 3:42 am

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